FCA reveals dire outcome of disorderly net-zero scenarios

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The Financial Conduct Authority (FCA) has presented a range of regulatory and operational strategies for three different long-term climate scenarios. They were introduced today (19 July) in the regulator’s first climate-related financial disclosures.

The three scenarios were proposed by the Network for Greening the Financial System. They include net zero 2050–orderly scenario, divergent net zero, and current policies.

The net zero 2050 – orderly scenario assumes that climate policies will be introduced early and gradually become more stringent.

This would result in global warming being on track to be limited to 1.5 °C. Both physical and transition risks would relatively be subdued.

In this case the regulator expects its ESG strategy and wider FCA strategy to remain relatively resilient.

It will monitor companies climate disclosures “to continuously evaluate the financial sectors transition pathway” and act with regulatory interventions to support this where needed.

It adds: “Increased supervisory resource may be required to assess potential consumer harms across retail sectors like general insurance and mortgage lending where transitional risks may reduce consumer access.”

Net zero would be reached by 2050 with global warming on track to being limited to 1.5 °C. Yet, it would result in higher costs and a high burden being placed on consumers.

This scenario would see a need for the FCA to devote additional resource to strengthening international ESG regulatory co-ordination. This would be due to divergent policy approaches being taken across jurisdictions.

Disorderly price adjustments and increased tail risks would also likely increase firm failure.

Therefore, additional supervisory resource would be required to support client asset resolutions.

Enhanced supervisory oversight and increased attention to the needs of vulnerable consumers would also be required.

This is because poor policy co-ordination could result in sudden product changes. It could impact the ability of consumers to access and afford general insurance and mortgage lending.

“This would reduce our ability to effectively resource many of the business-as-usual activities we undertake to protect consumers and financial markets and promote effective competition,” the FCA states.

As for its own operations, the FCA expects the strategy to be similar to the net zero 2050 one.

“Our transition planning would likely need continuous iteration and additional resource given the divergent nature of the transition,” the regulator added.

The current policies scenario assumes that few additional climate policies are implemented in jurisdictions.

Global efforts would be insufficient to halt significant global warming. As a result, emissions would rise until 2080 and at least 3°C warming. This leads to severe physical risks and impacts.

Many of the negative effects expected under a divergent disorderly scenario would apply  more acutely in this scenario.

The FCA warned that worsening economic conditions and reduced long-term savings levels could significantly weaken many consumers’ financial resilience and increase vulnerability.

Firms providing secured lending and insurance underwriting relating to assets exposed to physical risks would also face severe financial losses.

The regulator states: “Responding to significant consumer harms such as reduced access to products, poor treatment of vulnerable consumers and sale of unsuitable products across retail sectors would likely require a large amount of supervisory resource.

“We would also need to strengthen our oversight of how firms offering general insurance and mortgage lending factor granular physical risk data into their decision-making.

“Our regulatory strategy would need to focus almost entirely on responding to crystallising harm and away from more discretionary activities including thematic supervisory work, market intelligence and innovation related activity.”

In this scenario, the FCA itself could face business continuity disruptions. They would be attached to a significant increase in heatwaves, flooding and power outages.

The regulator states: “Such extreme weather events could disrupt the ability of staff to work both in the office and at home.

“In June 2021, flooding across parts of east London, in close proximity to our Stratford office, demonstrated that flooding represents a material physical climate risk for the organisation.

“The organisation would therefore need to continue to invest in ensuring all of its activities, and that of its core suppliers, service providers and data centres, can be carried out remotely where necessary.”

The FCA says that each of these scenarios show the importance of integrating climate considerations across its functions.

It aims to strengthen its use of scenario analysis for its next year’s climate-related financial disclosure.

This will include further depth and coverage of quantitative impacts, leveraging improved data, disclosure by real economy and financial firms, climate science and improved methodologies.

“This will help us build out a central climate transition scenario for industry, based on commitments, targets and strategies set out by firms, and our work to support the delivery of that scenario,” the FCA adds.

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